Opinion: Outside forces buffet the euro zone at just the wrong time

Martin Weale, an external member of the U.K.’s Monetary Policy Committee, had his doubts early on about the Bank of England’s policy of forward guidance. He said last month there was little evidence that forward guidance was boosting growth and the rapid fall of British unemployment strengthened the case for higher U.K. interest rates.

Since August, the Bank of England’s forward guidance has said that interest rates would remain on hold at least until unemployment falls to 7% — a condition which, as a result of better-than-expected U.K. economic recovery, may have been achieved in December.

The prospective tightening in the U.K. — the euro bloc’s most important trading partner — as well as cautious ‘tapering’ of Federal Reserve monetary stimulus and uncertainties in leading emerging market economies mean that the resolve of Europe’s policy makers to shore up the still-ailing euro
EURUSD, -0.0763%
will be tested at an unpropitious time.

A combination of political and economy circumstances will make 2014 a lot less benign than 2013 for euro-area peripheral country debt and equity markets.

Just as the euro area was eventually badly hit by the fallout from the Lehman Brothers bankruptcy in September 2008, gathering turbulence in exposed developing nations, ranging from Argentina and South Africa to Russia and Turkey, will have big repercussions for the euro bloc.

More centrally, home-grown problems have not been resolved. Battered President François Hollande of France has announced structural economic reforms akin to the ones that allowed Germany to reinvigorate its economy — in much less difficult external circumstances — 10 years ago, but is a long way from implementing them.

The European Parliament is likely to see extremist anti-European parties taking over a significant number of seats in the May elections. The rise of the anti-euro Front National presents a particular problem for Hollande.

Despite a slow recovery over the past 12 months, the euro area remains as fragmented as ever. The gulf is between the better-performing northern creditor countries, led by Germany, and the badly hit southern and western nations that have restored balance-of-payments equilibrium thanks to austerity that has produced record-breaking unemployment in several countries and destroyed growth prospects for a generation.

European central bankers, while broadcasting worries about the slow pace of reforms in Europe, have been dropping hints that the delayed German Constitutional Court decision on the European Central Banks outright monetary transactions bond-buying program might be negative for markets.

The euro authorities believed that, by the time the court announced its decision, financial markets would have recovered sufficiently that they could take any restrictive judgment (such as placing Bundestag-authorized limits on Bundesbank involvement in OMT) in their stride. This may no longer be the case.

Conditions in Berlin are somewhat fraught. Chancellor Angela Merkel has been sidelined as a result of a skiing accident. Her deputy in the Grand Coalition, the fiery Social Democrat leader Sigmar Gabriel, has been doing his best to outshine her in recent weeks — leaving doubts about the effectiveness of Germany’s euro policies.

The world has entered the New Year with global risks seemingly under control. However, Mario Draghi, the ECB president, has warned that the European crisis is not over and that the ECB has no special plans such as U.S.-, U.K.- or Japan-style quantitative easing to restore health to the European economy.

He has signaled that ECB may fight deflation in Europe by buying packages of bank loans to households and companies — a plan that has been discussed for months but has been difficult to bring to fruition.

Just as last year the financial markets were far more bullish than would have been justified by economic circumstances, this year this process may go into reverse.

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